A more optimistic outlook for the bond market has begun to emerge among many of the market's participants. At the same time, a cautious approach is being exercised in purchasing bonds. The optimism arises from several factors. Analysts feel that the monetary aggregates--especially the errant M1 aggregate--are being reined in. They point out that the growth in M1 from July of 1982 through July of 1983 was a whopping 13 percent. But the last eight weeks have shown a growth of only 7.3 percent. As a consequence, they feel, the decelerating growth in time will remove any necessity for the Federal Reserve to tighten credit further.
Analysts also are pointing to the reduction in the Treasury's onerous debt financing, which has smothered the markets and has helped to place a floor under interest rates. In May, the Treasury had projected new cash needs of $55 billion to $60 billion during the third quarter. In August, the Treasury revised that figure to $48 billion. In actuality, it looks as if it will raise $43.5 billion in new money. That certainly still is a great amount of borrowing, but it could have been worse.
It also appears that the Treasury will have a larger cash position at the end of this quarter than it originally had projected. Consequently, the Treasury will be able to use a portion of its cash position to reduce some of its financing needs for the fourth quarter. Every little bit helps.
Finally, some slowing in the torrid growth of the economy is occuring. This, perhaps, accounts for the slowing of the monetary aggregates as well. It also means to the soothsayers that a cooling down of the economy will help curtail credit needs from the private sector. This, in turn, reduces the possibility of a "crowding out" of borrowers with its higher interest rates.
On the other hand, the cautious approach to the market stems from much of the foregoing simply being conjecture and not a unanimous view. Larry Kudlow, formerly of the Office of Management and Budget, has a contrary view. He feels the economy is pausing and will continue its strong growth through early next year. At the same time, Kudlow fears that the velocity, or the rate of turnover, of money will increase with the recovery, which could push short-term rates higher by year end. Kudlow also believes that the shooting down of the Korean airliner, plus the troubles in Lebanon and Central America, will make it difficult to curtail military spending, and that these factors, coupled with congressional inaction on domestic spending, will render it impossible to reduce the budget deficits in the near term. Finally, Kudlow points out that the two leading indicators of future inflation have been turning up steadily and would indicate higher interest rates. Hence, the caution in purchasing bonds.
Interestingly, in looking over the recent yields on tax exempts and Treasuries, we find that, during the last few weeks, the yields have been close to their 1983 highs. Even the yields on six month tax-exempt project notes are cheap when they are compared with the returns available on six-month T bills. So, for the optimistic investor, there are good purchases available.
Also, the Treasury will offer a two-year note on Wednesday in minimums of $5,000. They should return 10.65 percent.